Indonesia Mounts Its Defence in Int'l Currency War

Just a little over a decade ago, Indonesia was the epicentre of the Asian financial crisis. In a matter of months, the local currency, the Indonesian rupiah (IDR), had lost eighty percent of its value as foreign investors fled the country as quickly as they came. After all, they call it "hot money" for a good reason. Amidst all this were food riots, race riots, and various separatist movements trying to take advantage of the seeming loss of control by the central government. By 1998, harsh IMF conditionalities had helped ease out the long-running Suharto regime.

But that was then and this is now. The--how should I describe them--flatulent fiscal and monetary policies of the Americans, currency warriors extraordinaire, now threaten to overwhelm Indonesia's financial stability. Like in so many other countries in the region, the nearly unlimited ammunition the Yanks threaten to use causes asset bubbles, inflation, and a diminution of export performance.

And so it has come to pass that our Indonesian colleagues have sounded the warning bells. While not slapping capital controls per se, there has been considerable use of macroprudential measures such as increasing reserve requirements. It should be noted that the Chinese use a lot of this tinkering as well:

Indonesia said it will tighten rules on banks’ foreign-exchange holdings and overseas borrowing to cope with capital inflows that have pushed up inflation and strengthened the rupiah this year. Bank Indonesia will also reintroduce a 30 percent cap on lenders’ short-term overseas borrowing to minimize the risk of sudden capital outflows, it said yesterday. Banks must set aside 5 percent of their total foreign-exchange holdings as reserves as of March 2011, from 1 percent currently, Deputy Governor Budi Mulya said at a press briefing in Jakarta yesterday. The reserve requirement will rise to 8 percent effective June.

“These rules will ease pressure on the rupiah,” said Anton Gunawan, chief economist at Jakarta-based PT Bank Danamon Indonesia. “The central bank wants to absorb excess liquidity in the banking system.” Indonesia and its peers are grappling with increasing capital inflows as borrowing costs and growth rates that are higher than those of developed economies boost the appeal of emerging-market assets. Taiwan tightened curbs on exchange-rate derivatives this week and South Korea plans similar measures, according to an official at the country’s financial regulator...

Bank Indonesia has resisted imposing capital controls or raising its benchmark interest rate from a record-low 6.5 percent, choosing instead to increase bank reserve requirements and encourage investors to keep their money in the country for longer periods. The current benchmark rate is consistent with Indonesia’s goal of achieving inflation of 4 percent to 6 percent in 2011 and 3.5 percent to 5.5 percent in 2012, Mulya said yesterday.

The higher foreign-exchange reserve ratios may absorb as much as $3 billion in excess liquidity, and are “prudent banking” measures aimed at helping Southeast Asia’s largest economy cope with capital inflows, Mulya said. “If money is pulled into the reserve requirement then it cannot circulate within the system,” said Purbaya Yudhi Sadewa, an economist at PT Danareksa Research Institute in Jakarta. “That’s a disincentive to avoid banks attracting too much dollar since they must pay interest on that dollar whereas the money is put away at Bank Indonesia, which may not even earn interest.”

Lenders will be required to limit their short-term overseas borrowing to no more than 30 percent of their capital starting in January, the central bank said. The rule aims to encourage a shift to long-term foreign borrowing and reduce the risk of sudden reversals in capital flows, it said. The requirement was scrapped in 2008 because of the global financial crisis...

Five state-owned Indonesian financial institutions, including PT Bank Mandiri, have given their commitment to buy back bonds to ease the impact of sudden capital outflows during a crisis, Agus Suprijanto, acting head of fiscal policy at the Finance Ministry, said this week. The government is still in talks over the use of their funds and will prioritize funding from the state budget for any buybacks, he added.

Indonesia will also require lenders with assets of at least 10 trillion rupiah ($1 billion) to announce their prime lending rates, effective in March 2011. This rule will push banks to decrease their net interest margin and become more efficient, the central bank said. Lending growth may reach 22 percent this year, it said.

Bridging the Asian financial crisis era of foreign exchange pouring out and today's Indonesia with money pouring in, keep in mind that former Indonesian Finance Minister Sri Mulyani Indrawati has become a managing director at the World Bank for her widely praised efforts to stabilize Indonesia's economy post-financial crisis. Aside from reining in foreign short-term borrowing, she also did much to address the pervase corruption of the Suharto era. We wish our fellow Southeast Asians all the best, and I guess it's better to have problems dealing with excessive foreign exchange inflows instead of the opposite, right?